A Shell by Any Other Name?

Pity the young company ready to take the big leap into the capital markets. Pick the traditional initial-public-offering route and you enter a still-lackluster IPO market with uncertain prospects for all but the hottest corporate candidates. Go with a private-equity buyer and you give up control as well as the liquidity only public markets can offer.

Little wonder that more companies are choosing a third, once discredited, option: going public through a merger with an existing shell — in this case, one in the form of a special-purpose acquisition company, or SPAC. In the current IPO market, this offers the best of both worlds for some private concerns.

Take Jamba Juice Co. After rejecting the idea of an IPO in 2005, executives at the San Francisco–based purveyor of fruit smoothies had all but sealed its sale to a strategic buyer. Then they met Steve Berrard. Late last year, Services Acquisition Corp. International (SVI), the SPAC managed by Berrard, purchased and recapitalized Jamba Juice for $265 million. Today it does business as Jamba Inc.

Safety from the SEC
Sometimes referred to as blank-check companies, SPACs represent a growing portion of the IPO market. The 40 SPACs created last year accounted for 16 percent of all IPOs, according to capital-markets analysis firm Dealogic. Meanwhile, the average capitalization for a SPAC nearly tripled over the past three years, to $117 million. Those having completed their IPOs now seek targets in sectors including energy, information services, health care, consumer products, and financial services (see "SPAC-ing Out" at the end of this article).

Since SPACs are publicly traded shells, they have inherited some of the notorious history forged by unscrupulous operators who once used shell companies as fronts for scams. Fifteen years ago, the Securities and Exchange Commission issued Rule 419 to offer some safeguards for investors in shell companies. Many SPACs adhere to Rule 419's guidelines.

By following Rule 419, a SPAC like SVI launches its IPO, listing no assets, and places in escrow at least 80 percent of the money raised from the offering. It uses the remainder of the capital to cover company expenses. SPAC investors — primarily institutions — are placing a bet on the management group and its deal-making plan, often aimed at sectors where the managers have track records. The SEC guidelines typically give managers 18 to 24 months to buy a company, or they must liquidate and return the escrowed capital to holders.

Flexible Exits
For managers and investors in a target company like Jamba Juice, going public this way offers certain advantages. One is the choice of individual exit strategies. Some original Jamba investors wanted to liquidate their holdings, while others (along with the executive team) wanted to stay involved. The SPAC accommodated both desires. Jamba Juice CEO Paul Clayton and CFO Donald Breen stayed in charge.

As an entrepreneur, "if you want to walk away, you'll probably sell to a strategic buyer" rather than to a SPAC, says Bob Marbut, CEO of Argyle Security Acquisition Corp., a San Antonio–based SPAC that is exploring targets in the security-equipment business.

Breen and Clayton had rejected doing their own IPO, Breen says, in part out of concern that the company's short-term volatility would spook investors and overshadow its steady same-store sales growth. In contrast, SVI's managers understood the explanation that Jamba managers gave. It's not that SPAC investors are less selective than investors in a traditional IPO; it's just that fewer underwriters are willing to write IPOs in the $30 million to $100 million range.

Like many of their peers, Jamba's executives and investors preferred going public to tapping the private-equity markets. That's a common feeling, according to Sheldon Goldman, senior managing director with broker-dealer Goldman Advisors LLC. Private-company managers like the liquidity, while investors prefer the superior governance of the public markets. "It was the right decision for us," says Breen. Jamba received a stronger capitalization — $265 million — than it would have with a traditional IPO.

Acquisition-by-SPAC can also bring much more cash into a young company than either a simple IPO or a private-equity infusion. In January, PharmAthene Inc., a private developer of countermeasures for biological and chemical weapons, announced it would be bought by Healthcare Acquisition Corp., a SPAC that had raised about $70 million through its IPO. "This allows us to accelerate product development," says PharmAthene CFO Christopher C. Camut. Based on typical biotech multiples, his firm would have raised only about $20 million to $35 million in an IPO, he figures.

Indeed, the weak IPO market makes SPACs a more attractive alternative for entrepreneurs. "In the last five years, there's been a retreat from the small and midsize IPO market by investment banks," says Brett Goetschius, editor of Reverse Merger Report. Moreover, notes Neil Danics of SPAC Analytics, "with an IPO, you're subject to the mood of the market."

Not for Everyone
SPACs are not the perfect alternative. For one thing, only certain types of companies make good targets. Most SPACs seek established operations that generate operating cash flow and can display several years of audited financial statements. For another thing, there's no guarantee a deal will be completed. Even if an acquisition is proposed, both the SEC and the SPAC's investors — typically at least 80 percent of them — must approve it.

Then the company must deal with accounting regulations, which generally weren't written with SPACs in mind. "This was a unique transaction that will require a lot of interpretation," notes Jamba's Breen. When it came to qualifying for an exemption from filing deadlines for Sarbanes-Oxley's Section 404 internal-controls provision, "we applied and got it," he says. But in general, when it comes to dealing with the SEC, "there is no clear-cut documentation or ruling that would give you comfort."

While it's hard to predict whether the current popularity of the SPAC approach will continue, some think the outlook will be clearer by year-end. Brian North, an attorney with Buchanan Ingersoll & Rooney, notes that the 30 SPACs that went public in 2005 now are reaching the two-year deadline for making an acquisition or liquidating. If the liquidation rate is low, investor enthusiasm may get yet another boost. If not, interest may die down.